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  • Writer's pictureRaphael Benhamou

Financial Modeling Unleashed: The 3-Tier Approach

Updated: Sep 20, 2023


A 3 tier cake representing layers of modeling

In the world of financial modeling, accuracy, adaptability, and strategic insight are the cornerstones of success. As an experienced Financial Consultant, I've encountered numerous challenges and complexities throughout my career. In response, I've developed a robust and highly effective methodology - the 3-Tier Approach - that not only addresses these challenges but propels financial modeling to new heights.


Tier 1: What You Know


A data funnel
Data being processed into value

Before diving into the specifics, let's break down this methodology. At its core, it consists of three key tiers, each building upon the last. Tier 1 is all about what you already know. It encompasses the data, facts, and figures readily available. This is the foundation upon which your financial model is constructed.


While Tier 1 might seem straightforward, its significance cannot be overstated. Accurate and comprehensive data is the lifeblood of any financial model. But there's a catch - it's not just about the data itself; it's about structuring it logically. Freeform spreadsheet tools like Excel and Google Sheets often encourage users not to think about structure. Rows, columns, and cells can be added and moved around effortlessly, making it tempting to postpone structural considerations. However, this approach can be a recipe for disaster.


Tier 1 sets the stage for everything that follows. Logical structure here is equally vital. It's not just about rows and columns; it's about the interplay of data, the architecture that enables swift analysis, and the foundation for strategic insights.


Tier 2: What You Are Fairly Confident About


A road showing the immediate future
What you can see in your immediate future

With a robust Tier 1 in place, we move on to Tier 2. Here, we explore what you are fairly confident about. This tier involves analyzing historical trends, understanding market dynamics, and identifying patterns in your data. It's about converting raw data into actionable insights.


To illustrate the power of Tier 2, consider a real-world scenario. A client was struggling to manage their cash flow and set achievable revenue goals. By building their revenue model using this structured approach, they gained a deep understanding of future revenue projections and could formulate realistic revenue targets. This knowledge was instrumental in crafting a marketing strategy that allowed them to reach their targets while maintaining a steadily growing cash flow.


Tier 3: What You Would Like to Happen

A crystal ball to look into the future
Looking to the future

Now, we reach the pinnacle of financial modeling - Tier 3: What You Would Like to Happen. Here's where strategic planning and forward-thinking come into play. Tier 3 involves making assumptions, predicting future trends, and scenario planning. It's where the artistry of financial modeling truly shines.


To highlight the power of Tier 3, consider another case. A client had successfully raised funds and wanted to scale their operations aggressively while ensuring a reasonable runway. Using this methodology, we identified how much of their burn rate came from current hires, immediate incoming hires, and various scenarios for continued expansion. This strategic planning not only managed their runway effectively but also helped realize their operational goals.


Bridging Strategic Goals with Operational Directives


But there's more to the 3-Tier Approach than meets the eye. It serves as a powerful bridge between top-level strategic goals and operational directives. In the dynamic landscape of business, it's not enough to set ambitious targets from the boardroom; those targets need to be realized through operational excellence.


This bridging process involves creating:

  • Clear Links: Establishing clear links between various aspects of your organization. For example, understanding how hiring salespeople impacts revenue and expenses, or how an increase in customers drives hiring planning for customer support. The goal is to connect operations to finance at every level.

  • Integration: Blending top-down strategic goals with the bottom-up approach of Tiers 1 and 2. This integration ensures that operational directives align with strategic objectives.

  • Explicit Assumptions: Defining assumptions explicitly rather than hard-coding them into formulae. This approach allows for easy scenario analysis, making your financial model agile and adaptable.

  • Granularity: Maintaining data granularity at a level where operational data is collected or where stakeholders naturally think about the business. This may mean forecasting revenues by product rather than individual contract/client, aligning with how business owners conceptualize their operations.


By implementing these principles, a financial model owner gains a deep understanding of the business, from its core data to top-level strategic goals. This holistic view empowers you to not only chart a clear vision of your organization but also provide actionable, operational recommendations to achieve executive goals over the long term.


Conclusion


In a world of ever-evolving business dynamics, mastering financial modeling is a game-changer. The 3-Tier Approach empowers you to harness the power of your data, convert it into actionable insights, and bridge top-level strategic goals with operational directives. It's not just about numbers; it's about strategy, adaptability, and making informed decisions that drive growth.


By structuring your financial models logically and systematically across these three tiers, you not only enhance accuracy but also future-proof your financial strategies. It's not just a methodology; it's a transformative approach that enables you to navigate the complex terrain of modern business with confidence.


In upcoming articles, we'll delve deeper into each tier and explore practical insights and tips to elevate your financial modeling game. Stay tuned for more!


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